Ross Douthat Argues that Social Security Would be Easier to Cut If It Were Changed from a Social Insurance Program to a Welfare Program

Sunday, 25 November 2012 08:14

Ross Douthat argues convincingly that if we eliminated the link between contributions and benefits it would be much easier politically to cut Social Security. Of course he thinks ending the link would be a good idea for that reason, but his logic is certainly on the mark, people will more strongly protect benefits that they feel they have earned.

Douthat is off on a few other points. He tells readers:

"In an era of mass unemployment, mediocre wage growth and weak mobility from the bottom of the income ladder, it makes no sense to finance our retirement system with a tax that falls directly on wages and hiring and imposes particular burdens on small business and the working class.

"What’s more, the payroll tax as it exists today can’t cover the program’s projected liabilities anyway, and the pay-as-you-go myth stands in the way of the changes required to keep Social Security solvent."

The problem here is that we are not condemned to an era of "mass unemployment, mediocre wage growth and weak mobility." This has been the outcome of inept macroeconomic policy and trade and regulatory policies that were designed to redistribute income from those at the middle and bottom to the top. Most people would look to reverse these policies rather than eliminate social insurance.

The implication of this comment, that we would somehow be able to make up substantial funding shortfalls from cutting taxes on low and middle income people by taxing the wealthy more also is not very plausible. Given the enormous political power of the "job creators" (as demonstrated by the fact that people are not laughed out of town for using this term), it is unlikely that substantially more money will be raised from the wealthy to pay for Social Security. This means that in Douthat's dream world we would be seeing large cuts in benefits.

He also is wrong with his arithmetic. The payroll tax certainly can cover the program's expenses. In fact, had it not been for the upward redistribution of income over the last three decades, which nearly doubled the share of wage income going over the cap on taxable income, the projected 75-year shortfall would be about half of its current level.

Even with the current projected shortfall, if ordinary workers shared in projected productivity growth over the next three decades, a tax increase equal to 6 percent of their wage growth over this period would be sufficient to make the program fully solvent. The problem is clearly the policies that led to the upward redistribution of income (e.g. protectionist policies for higher paid professionals, stronger patent and copyright monopolies, subsidies for too big to fail banks etc.), not Social Security.

It is worth pointing out that when Douthat proposes "means-testing for wealthier beneficiaries," his notion of wealthy means school teachers and firefighters, not Bill Gates and Mitt Romney. There are a small number of very rich people, cutting some or all of their benefits won't make any difference to the program's finances. In order to have any appreciable effect on Social Security's finances it would be necessary to cut benefits for people who earned $40,000 a year or thereabout.

Finally, Douthat refers to "changing the way benefits adjust for inflation." Douthat is not interested in "changing the way benefits adjust for inflation," he is interested in reducing the way that benefits adjust for inflation. The most widely touted proposal would be equivalent to a 3.0 percent cut in lifetime benefits. This would have a larger impact of the income of most beneficiaries than the ending of the Bush tax cuts would on the after-tax income of most of those affected. For this reason, it is understandable that there would be resistance just as there is considerable resistance to "changing" the tax rate for high income taxpayers.

Some good points from someone I usually don't agree with. I suspect, though, he wants to limit the payroll tax to eventually starve Social Security and Medicare and so cut their benefits to those who pay into them. Here are some additional facts, not generally understood about the "Payroll tax."

1. The Payroll tax is the "Social Security and Medicare Tax" and is distinct from the income tax. Your 1040 deals with your income tax. Like the income tax, the payroll tax is taken out of your weekly wages but is not considered in your tax return, since there are no deductions that can be claimed to reduce it in any way. The payroll tax is generally listed as "FICA" on your pay stub

2. The rate is usually (in the absence of the holiday about to expire) is 7.65% of wages under about $110,000 & has 2 parts: a) 6.2% for Social Security on any wages under about $110,000. Thus if you have wages of $1,100,000 your effective Social Security tax is .62%, 10 times lower than that paid by a minimum-wage worker b) Plus 1.45% for Medicare on all your wages

3. Your employer matches what you pay and sends that to the federal government. Most economists agree that that additional 7.65% ends up coming out of the worker's pocket. Since employers know they will have to pay this when they hire you, they offer you that much less salary.

4. All investment income and gains are exempt from the payroll tax. If you inherited 1 billion dollars, which earns you $100 million dollars in interest, dividends, and capital gains each year, and don't draw a salary, your payroll tax is $0.

douhat's use of the term "payroll tax" reminds me of the GOP "death tax" campaign

is this another frank luntz focus group tested term?

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Holidays Forever?written by Bart,
November 25, 2012 12:53

Won't the Payroll Tax Holiday, sure to be extended or its bite increased, eventually maybe not starve, but put Social Security on a diet?

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...written by JSeydl,
November 25, 2012 3:00

Thanks for the primer post, PeteG2. Good info. Oh, and the fair share tax reform plan looks pretty interesting on the surface.

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...written by coberly,
November 25, 2012 4:08

Seydl

actually PeteG2 is wrong. He is misled by thinking of Social Security as a "tax." It is better thought of as an insurance program. The "rich" don't pay 6% of all of their income because that would be an absurd price for the insurance they are getting. They do pay 12% of the first 100k or so. That is a reasonable price for the insurance they are getting... against the possibility that after a lifetime of work they could end up "not rich." or even dirt poor. it happens.

"most economists" said that the employers share was really the workers money when they wanted the workers return on investment to look smaller than what the stock market was paying. after the market crashed they decided the payroll tax was really a "jobs killing tax." it can't be both... except to the liars who want it both ways. but even that 12.4% "tax" is a pretty good deal. you get it back with interest when you need it most. you might be able to do better on the market... but you might also lose your shirt at the worst possible time.

workers can continue to pay for their own social security by rasing their own payroll tax about eighty cents per week per year. this would guarantee they could retire at the present retirement age, at a larger benefit than today's.

trying to turn it into welfare by "scrapping the cap" guarantees you will lose it in the end. "the rich" are not going to pay a hundred thousand dollars a year on a million dollar income to pay for your retirement. and you shouldn't want them to.

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...written by ezra abrams,
November 25, 2012 5:47

quote He also is wrong with his arithmetic. The payroll tax certainly can cover the program's expenses. In fact, had it not been for the upward redistribution of income over the last three decades, which nearly doubled the share of wage income going over the cap on taxable income, the projected 75-year shortfall would be about half of its current level. unquote

DB - one heck of a paragraph there; earned your pay today, for sure

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...written by coberly,
November 25, 2012 7:30

ezra hard for me to understand what you are saying here.

according to the Trustees projections the payroll tax would need to be raised about 2% for each the workers and their employers in order to pay for "scheduled" benefits over the next seventy five years. But that increase can happen gradually over that time... about one half of one tenth of one percent per year (combined worker and employer tax). because of the recession it now needs to be frontloaded to about the first twenty years of that time... after that it probably will not need to be increased at all. And even with the frontloading, the cost to the average worker would be an extra eighty cents per week each year while his wages are going up eight dollars per week. and this would pay for a lot longer retirement at a benefit level that rises to twice the real value of today's.

the wage inequality thing is true, and should be addressed. but it is not strictly a problem with Social Security, and raising the cap would NOT be a good idea... it would tend to tax people who will not get the benefit... turning SS into welfare, which is exactly what Dean is saying here is a bad idea. I agree with him.

i am not sure he would agree with me. there are people who think they can raise the cap and pretend SS is still "worker paid" and that the millionaires paying an extra hundred thousand a year for SS they will not collect won't notice and won't do anything about it.

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Increase SS Benefitswritten by FoonTheElder,
November 26, 2012 11:36

Contrary to popular media opinion, US Social Security is already one of the lowest benefit social retirement programs in the developed world.

Just like US medical, you don't get that much for what you pay for.

If you really want to create jobs, allow the elderly to retire with a Social Security benefit they can actually live on. If that requires regular tax money to be added to SS, so be it.

It sure beats giving more big tax breaks to the wealthy and big corporations who don't need it (like Mitt Romney). According to an article in Boston.com, Massachusetts spends more on tax breaks than they actually receive in taxes.